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This Strategy Still Wins

I'm sure I'm not the only one leaving my portfolio statements unopened these days. No one takes pleasure in seeing 10%, 20%, or even more evaporated from their accounts in a matter of hours thanks to the meltdown consuming once-grand institutions such as AIG (NYSE: AIG) and Lehman Brothers.

The recent panic and market gyrations have many investors looking for calmer pastures -- some area of the market where they don't have to endure the 25% drops that seem to come and go almost daily now. Thankfully, studies show that there is one strategy that not only continues to fuel tremendous growth in portfolios but also combats volatility at the same time.

The smart way to duck and coverThat strategy has been emphasized again and again here at the Fool: global diversification. This may strike investors as passe, as some foreign stocks that generate the bulk of their revenue and earnings from markets outside the U.S. are taking big hits these days. For instance, despite achieving record output, Brazilian oil giant Petrobras (NYSE: PBR) is down more than 50% this year.

But drawing conclusions from a broad stock market sell-off may have investors missing out on companies like Taiwan Semiconductor Manufacturing (NYSE: TSM) , whose competitive advantage keeps sales strong while peers struggle in down cycles.

But isn't global investing past its prime?Many economists have argued that globalization and the ongoing integration of international financial markets have diluted the diversification benefits of foreign stocks for investors.

A recent study contradicts this finding, however. Although global markets are far more integrated than they were a few decades ago, Wharton finance professor Karen K. Lewis found that over the past 20 years, the correlation between foreign and U.S. markets has increased only slightly and that the volatility of foreign stocks has decreased. The end result is that there are still significant benefits to having foreign stocks in a portfolio.

Consider also that a recent Wall Street Journal article noted that "a leading index of big-cap stocks in developed overseas markets yielded a 3.7% [dividend] payout as of July 31, compared with a 2.4% rate for similar U.S. stocks." This difference can be seen in London-based integrated oil & gas company BP's (NYSE: BP) average five-year dividend yield of 3.3%, while domestic peer ExxonMobil (NYSE: XOM) has averaged only 1.9%.

Look who's winning with internationalOver the past several years, many of those who have already heeded the call to balance a portfolio with international stocks are scoring big gains. For instance, Harvard University's $38 billion endowment fund is estimated to have generated between 7% and 9% returns in fiscal 2008 compared to a 15% loss in the S&P 500 during same 12 months. The fund achieved this thanks in part to allocating 22% of the portfolio in foreign equities while only 12% was placed in U.S. stocks. Over the past five years, Harvard's foreign equities asset class has yielded a 17.7% annualized return.

Even the market that many have dismissed as so yesterday -- China -- has banks still reporting big profits and maintaining strong business while U.S. banks like Citigroup (NYSE: C) and Washington Mutual (NYSE: WM) have posted massive write-downs. For instance, Industrial & Commercial Bank of China posted a 57% rise in profit in the first half of 2008, helped by the fact that only 0.09% of its assets are tied to the U.S. subprime market (and a miniscule 0.01% are linked to Lehman Brothers). While China's GDP growth is expected to decline somewhat in response to a U.S. slowdown, the country will still post a resilient 8.5% growth rate in 2009, according to figures from the International Monetary Fund.

The Foolish bottom lineCertainly, the past year has seen big declines in foreign stocks; only three markets -- Switzerland, Sri Lanka, and Venezuela -- have avoided 30% declines. Some of these drops are warranted, and some are not. Panicky investors frequently sell out of foreign holdings along with their U.S. counterparts. Additionally, huge numbers of hedge funds with international investments are finding themselves forced to liquidate their positions in the face of redemptions and margin calls. But in the long run, diversification in quality foreign stock helps add stability to a portfolio -- and more importantly, gives you a shot at some of the world's best opportunities to profit.

With the recent global sell-off presenting the opportunity to pick up quality foreign companies at a deep discount, our team of international analysts at the Motley Fool Global Gains service are even more excited than usual about the a chance to get in near the bottom of great international growth stories. If you've noticed your portfolio in need of a little global balance, you can get a full guest pass to Global Gains free for 30 days by clicking here.

Fool contributorDave Mockkeeps his lifesaver ring hung on the back of his door just in case. He owns shares of ExxonMobil. Petrobras is an Income Investor recommendation. The Motley Fool'sdisclosure policyinflates into a seaworthy speedboat if you pull the string hard enough.

Comments from our Foolish Readers

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I thought you would say "buy low" would be the strategy that still wins, e.g. buy IBM on dips and hold until this market becomes stable and raise again. IBM is not going away, and if we buy when the PE is under 10.... we will be getting a good deal. Another strategy would be to buy DUK... the same holds, and this stock also pays a good dividend. Will electric companies go away?

I thought you would say "buy low" would be the strategy that still wins, e.g. buy IBM on dips and hold until this market becomes stable and raise again. IBM is not going away, and if we buy when the PE is under 10.... we will be getting a good deal. Another strategy would be to buy DUK... the same holds, and this stock also pays a good dividend. Will electric companies go away?

I think there is money to be made in the foreign markets, but you just have to be willing to take the risk. There is so much information available but the hard part is knowing and understanding the impact that this global economic crisis will have on the foreign, and domestic, markets. I am still learning so much on My Investment Journey and everytime I think I "got it" BAM!